If you're running IIS 5.0, run your 2.0 apps either in "High Isolation", isolated from each other and 1.1 apps, or in "Medium Isolation", with all 2.0 apps pooled in one process.

You can choose High (Isolated) or Medium (Pooled) from the Application Protection drop-down list on the Home Directory or Virtual Directory property sheet in the IIS Manager, in IIS 5.0

If you decide to run your application as a separate process, or with other applications in a single pooled process, you will need to select High (Isolated) or Medium (Pooled) from the Application Protection drop-down list on the Home Directory or Virtual Directory property sheet. You should first create an application directory and designate it as either a Home Directory or Virtual Directory, if you haven't already done so. By default, all new applications are run in medium protection. You can run a very large number of applications at medium isolation, but you will only be able to run a few dozen applications at high isolation, because each process consumes significant resources.

How does the web server realize what framework to use when calling up a particular web app? By assigning it to the proper .Net Framework version in the ASP.NET tab in the website's "properties" in the IIS Manager.